SHIRE PHARMACEUTICALS GROUP PLC
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

1. Summary of Significant Accounting Policies

(a) Description of Operations

Shire Pharmaceuticals Group plc (Shire) and its subsidiaries (collectively referred to as the Company or the Group) is a global pharmaceutical company with a strategic focus on meeting the needs of the specialist physician. The Company has a particular interest in innovative therapies that are prescribed by specialist doctors as opposed to primary care physicians.

The Company is focused on the development of late stage projects and marketed products in the areas of central nervous system (CNS), gastrointestinal (GI) and renal.

Geographically, the Company has operations in the world’s key pharmaceutical markets, namely North America and Europe. The Company’s business is organized across four operating segments: US, International (covering territories outside of the US), Research & Development (R&D) and Corporate. Revenues are derived primarily from three sources: sales of products by the Company’s own sales and marketing operations, royalties (where Shire has out-licensed products to third parties) and licensing and development fees.

Following a strategic review in 2003, the Company announced its new business model in July 2003. Shire will search, develop and market but will not invent. The Company will seek to acquire products with substantive patent protection rather than just three years’ Hatch-Waxman exclusivity. The Company will also focus its in-licensing and merger and acquisition (M&A) efforts on the US market, and obtain European rights whenever possible. As part of this strategy the Company has developed a plan to achieve closer interaction between its development, marketing and sales activities.

The strategic review thoroughly evaluated the Group’s R&D pipeline and refocused resources on a number of projects, five of which are currently in registration, two are in Phase III and two in Phase II of development. This approach aims to deliver the combined benefit of increased returns and lower risks. Whilst Shire has refocused its R&D efforts to concentrate on areas where it has a commercial presence, it will be flexible in adding new therapeutic areas if appropriate product acquisition opportunities arise.

As a consequence of the change in strategy, the Company has announced:

• A North American site consolidation which commenced in 2004;
  
• The exit from early stage therapeutic research (Lead Optimization), which was completed in the third quarter of 2003;
  
• The agreement to sell the Company’s Biologics (vaccines) business to ID Biomedical Corporation (IDB); and
  
• The out-licensing of its non-core acute myelogenous leukemia treatment TROXATYL (toxacitabine) to Structural GenomiX Inc., in exchange for upfront, milestone and royalty payments.
  

During the three months to June 30, 2004, the Company has advanced its plans to reduce the number of North American sites from fourteen to four, including the opening of a new US headquarters office, in Wayne, Pennsylvania. The Company will close its sites in Newport, Kentucky and Rockville, Maryland. Shire’s world headquarters will continue to be located in Basingstoke, UK. The current estimated reorganization cost of $55 million in 2004, is shown in more detail in Note 10. There are still elements of the plan that need to be finalized and these may impact the total estimated costs of the reorganization.

There are inherent risks associated with any significant organizational change, including the possibility of disruption to the Company's business or the loss of key personnel. Although a project team has been set up to actively manage the process and the associated risks, delays to R&D projects, failure to attain sales targets or other disruption to the business could occur as a result of the reorganization.

Shire and IDB continue to make good progress towards the completion of the sale of Shire’s vaccines business. IDB is required to reimburse Shire at closing for the net costs of operating the vaccines business from June 30, 2004. The impending disposal of the vaccines business is shown in more detail in Note 4.

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The Company’s principal sources of revenues include:

• in the US, ADDERALL XR for the treatment of ADHD, AGRYLIN for the treatment of elevated blood platelets, PENTASA for the treatment of ulcerative colitis and CARBATROL for the treatment of epilepsy. In addition, the Company receives royalties on sales of REMINYL for the treatment of Alzheimer’s disease, marketed by Janssen Pharmaceutica NV (Janssen), and on EPIVIR, COMBIVIR and TRIZIVIR for the treatment of HIV/AIDS, marketed by GSK;
  
  
• in the UK and the Republic of Ireland, the CALCICHEW range, used primarily as adjuncts in the treatment of osteoporosis, and REMINYL, which was co-promoted with Janssen-Cilag until March 31, 2004. On March 31, 2004, the Company acquired from Janssen the exclusive commercialization rights to REMINYL in the UK and Ireland;
  
  
• in Canada, 3TC and COMBIVIR for the treatment of HIV/AIDS, and HEPTOVIR for the treatment of hepatitis (all marketed in partnership with GSK), AGRYLIN for the treatment of elevated blood platelets, and FLUVIRAL S/F, a vaccine for the prevention of influenza. FLUVIRAL forms part of the vaccines business and will cease to be part of Shire’s product portfolio following its impending disposal to IDB; and
  
  
• in the Rest of the World, royalties on the sales of ZEFFIX for the treatment of hepatitis B, marketed by GSK, and royalties on sales of REMINYL, marketed by Johnson & Johnson.
  

The Company has a number of projects in the later stages of development and in registration for marketing approval, including:

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(b) Basis of Presentation

These interim financial statements, which include the Description of Operations and the financial information in this Form 10-Q, are unaudited. They have been prepared in accordance with generally accepted accounting principles in the United States of America (US GAAP) and Securities and Exchange Commission regulations for interim reporting. Certain information and footnote disclosures normally included in financial statements prepared in accordance with US GAAP have been condensed or omitted pursuant to such rules and regulations. However, such information includes all adjustments (consisting solely of normal recurring adjustments), which are, in the opinion of management, necessary to fairly state the results of the interim periods. Interim results are not necessarily indicative of results to be expected for the full year.

The December 31, 2003 balance sheet was derived from audited financial statements but does not include all disclosures required by US GAAP. However, the Company believes that the disclosures are adequate to make the information presented not misleading.

Certain amounts reported in previous periods have been reclassified to conform to the 2004 presentation for the three months to June 30, 2004. In addition the 2003 financial statements and the results for the three months period to March 31, 2004 have been restated in this Form 10-Q to reflect the impending disposal of the vaccines business, which has been treated as a discontinued operation.

(c) Employee stock plans

The Company accounts for its stock options using the intrinsic-value method prescribed in Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (APB No. 25). Accordingly, compensation cost of stock options is measured as the excess, if any, of the quoted market price of Shire’s stock at the measurement date over the option exercise price and is charged to operations over the vesting period. For plans where the measurement date occurs after the grant date, referred to as variable plans, compensation cost is re-measured on the basis of the current market value of Shire stock at the end of each reporting period. Shire recognizes compensation expense for variable plans with performance conditions if achievement of those conditions becomes probable. As required by SFAS No. 123, “Accounting for Stock Based on Compensation” (SFAS No. 123), the Company has included in these financial statements the required pro forma disclosures as if the fair-value method of accounting had been applied.

At June 30, 2004, the Company had seven stock-based employee compensation plans, which are described more fully in the Company’s 2003 Form 10-K.

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The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of SFAS No. 123 to stock-based employee compensation.

(d) Accounting pronouncements adopted during the period

FIN 46R

In December 2003, the Financial Accounting Standards Board (FASB) issued a revision to FASB Interpretation No. 46 “Consolidation of Variable Interest Entities (VIE), an interpretation of Accounting Research Bulletin (ARB) No. 51” (FIN 46R), which requires a VIE to be consolidated by a Company that will absorb a majority of the VIE’s expected losses, receive a majority of the entity’s expected residual returns, or both, as a result of ownership, contractual or other financial interest in the VIE.

Prior to the adoption of FIN 46R, VIEs were generally consolidated by companies owning a majority voting interest in the VIE. The consolidation requirements of FIN 46R applied immediately to VIEs created after January 31, 2003, however, the FASB deferred the effective date for VIEs created before February 1, 2003 to the quarter ended March 31, 2004 for calendar year companies. Adoption of the provisions of FIN 46R prior to the deferred effective date was permitted. The adoption of FIN 46R had no impact on the Company.

(e) New accounting prounouncements

EITF 03-01

In March 2004, the Emerging Issues Task Force (EITF) reached a consensus on Issue 03-01, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (EITF 03-01 or the Issue). EITF 03-01 is applicable to (a) debt and equity securities within the scope of Statement of Financial Accounting Standards (SFAS) No. 115, (b) debt and equity securities within the scope of SFAS No. 124 and that are held by an investor that reports a performance indicator, and (c) equity securities not within the scope of SFAS No. 115 and not accounted for under the Accounting Principles Board Opinion 18's equity method (e.g., cost method investments). EITF 03-01 provides a step model to determine whether an investment is impaired and if an impairment is other-than-temporary. In addition, it requires that investors provide certain disclosures for cost method investments and, if applicable, other information related specifically to cost method investments, such as the aggregate carrying amount of cost method investments, the aggregate amount of cost method investments that the investor did not evaluate for impairment because an impairment indicator was not present, and the situations under which the fair value of a cost method investment is not estimated. The disclosures relating to cost method investments should not be aggregated with other types of investments. The

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EITF 03-01 impairment model shall be applied prospectively to all current and future investments within the scope of the Issue, effective in reporting periods beginning after June 15, 2004. The disclosure requirements are effective for annual periods for fiscal years ending after June 15, 2004. The Company does not expect the adoption of EITF 03-01 to have an impact on the Company.

2. Analysis of revenue, operating income and reportable segments

The Company has disclosed segment information for the individual reporting segments of the business, based on the way in which the business is managed and controlled. The Company’s principal reporting segments are by operational function, each being managed and monitored separately and each serving different markets. The Company evaluates performance based on operating income. The Company does not have inter-segment transactions.

The US segment represents Shire’s commercial operations in the United States and the International segment represents the commercial operations in the Rest of the World. The R&D segment represents all research and development costs incurred by the Company throughout the world. Corporate represents the royalty business that is managed at the corporate office and certain costs that are managed at the corporate office and not allocated to the other segments.

The results for the three and six month periods to June 30, 2003 and the three months to March 31, 2004 have been restated in this Form 10-Q to reflect the impending disposal of the vaccines business, which has been accounted for as a discontinued operation.

⁽¹⁾ Depreciation of manufacturing plants is included within cost of product sales. Depreciation and amortization relating to R&D assets are included within US and International segments.

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⁽¹⁾ Included in depreciation and amortization are the write-downs of intangible assets. Depreciation of manufacturing plants is included within cost of product sales. Depreciation and amortization relating to R&D assets are included within US and International segments.

⁽¹⁾ Depreciation of manufacturing plants is included within cost of product sales. Depreciation and amortization relating to R&D assets are included within US and International segments.

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⁽¹⁾ Included within the selling, general and administrative costs for the Corporate segment for the six months to June 30, 2003 is $7.2 million in respect of the former Chief Executive’s departure.

⁽²⁾ Included in depreciation and amortization are the write-downs of intangible assets. Depreciation of manufacturing plants is included within cost of product sales. Depreciation and amortization relating to R&D assets are included within US and International segments.

3. Earnings per share

Basic earnings per share is based upon the net income available to ordinary shareholders divided by the weighted-average number of ordinary shares outstanding during the period.

Diluted earnings per share is based upon net income available to ordinary shareholders divided by the weighted-average number of ordinary shares outstanding during the period, adjusted for the effect of all dilutive potential ordinary shares that were outstanding during the period.

Stock options to purchase approximately 18.0 million and 14.6 million ordinary shares for the three months and six months to June 30, 2004, respectively, were not dilutive and were therefore excluded from the computation of diluted earnings per share (2003: 18.1 million and 18.0 million, respectively).

Warrants to purchase approximately 1.4 million common shares for the three and six months to June 30, 2003 were not dilutive and were therefore excluded from the computation of diluted earnings per share.

The $370 million convertible loan notes are excluded from the calculation of weighted average number of shares for fully diluted earnings per share for the three months to June 30, 2004 as they were not dilutive.

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The following table sets forth the computation of basic and diluted earnings per share:

4. Discontinued operations

Impending disposal of the vaccines business

Shire Biologics (the vaccines business), is active in research, development, manufacturing and the commercialization of human vaccines. Its portfolio includes two marketed products: FLUVIRAL for influenza and NEISVAC-C for meningitis C in Canada, as well as a pipeline of product candidates for the treatment of streptococcus pneumonia, neisseria meningitidis, group B streptococcus and group A streptococcus.

The vaccines business was acquired as part of the merger with BioChem Pharma Inc. in May 2001. The vaccines business is no longer core to the Company’s global strategy following Shire’s strategic review announced in July 2003. On April 20, 2004, Shire announced that it had signed an agreement to sell the vaccines business to IDB, a Canadian-based biotechnology company. Closing of the transaction is subject to a number of conditions precedent, most of which have now been achieved. The Company expects that the remaining conditions precedent should be satisfied and closing should occur by September 30, 2004. Upon completion, IDB will reimburse Shire for the net cost of operating the vaccines business from June 30, 2004.

As of June 30, 2004, the net assets of the vaccines business have been reclassified as being held for sale and have been written down to their fair value, in principal recognition of (i) the Company’s decision to sell the net assets; (ii) the

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Company’s sale agreement with IDB; and, (iii) an assessment by the Company that it is probable that all conditions precedent will be met and the sale to IDB will be completed. The sale of the vaccines business has been classified as a discontinued operation because:

• the operations and cash flows of the vaccines business will be eliminated from the ongoing operations of Shire as a result of the impending disposal; and
  
  
• with the exception of the $100 million loan noted below, Shire will have no involvement in the continuing operations of the vaccines business after the impending disposal.
  

The total consideration for the sale will be $120 million of which $60 million will be received in cash in two equal installments, one at closing and the other on the first anniversary of the closing of the transaction. The remaining $60 million is expected to be received in common shares of IDB. If IDB completes one or more share offerings within 22 months of closing, Shire can elect to exchange all or part of these shares for all or part of $60 million of cash. Under the terms of the agreement, IDB is required to reimburse Shire at closing for the net cost of operating the vaccines business from June 30, 2004.

As part of the transaction Shire will enter into an agreement to provide IDB with a loan facility of up to $100 million, which can be drawn down over the four years following closing. It is expected that IDB will draw down the entire $100 million loan. This facility can be used by IDB to fund the development of injectable flu and pipeline products within the vaccines business acquired from Shire. This loan will be segregated into two components:

Combined drawings on the two components of the loan facility cannot exceed $100 million.

In writing down the net assets held for sale to fair value, the Company recorded an expected loss on the disposition of the vaccines business of $44 million. In doing this, the Company has considered the recoverability of amounts in respect of the $70 million loan for pipeline development.

In accordance with US GAAP disclosure requirements for discontinued operations the 2003 results and the results for the three months to March 31, 2004 have been restated. The results of the discontinued operation have been removed from all periods on a line-by-line basis from product sales revenue to income from continuing operations. The net loss from the discontinued operation, together with the expected loss on disposal, are shown as separate line items.

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Operating results of the discontinued operations are summarized below.

The operating results of the vaccines business represented the entire Biologics segment as well as certain parts of the International and R&D segments.

As a result of the impending disposal of the vaccines business the Biologics segment is no longer an operating segment of the Company and the International and R&D segments have been restated accordingly.

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The assets and liabilities of the discontinued vaccines operation are summarized below.

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Trade receivables are stated net of a provision for doubtful accounts and discounts of $7.4 million at June 30, 2004 (June 30, 2003: $5.8 million).

Throughout the period the Company assesses the carrying value of its investments for decreases in fair value and other-than-temporary impairments. Upon completion of this assessment, the Company wrote-off $7.2 million of investments during the six months to June 30, 2004 (June 30, 2003: $8.5 million). This has been reflected in other expense net, in the consolidated statement of operations.

At December 31, 2003, Shire held an investment in a private company that was entering the later stages of an Initial Public Offering (IPO). At December 31, 2003 the anticipated flotation price was used to value the investment. On March 25, 2004, this private company gained its listing, but the initial listing price was below the anticipated flotation price used at December 31, 2003. As a result, Shire recorded an impairment of $4.2 million to decrease the value of the investment to the initial IPO price. Any changes in fair value since that date are recorded in other comprehensive income. The Company wrote-off additional investments in private companies of $3.0 million based on changes in the estimates of their carrying value.

During the six months ended June 30, 2004, the Company sold an investment in a public company and realized a gain on the sale of $14.8 million.

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8. Other intangible assets, net

The useful economic lives of all intangible assets that continue to be amortized under SFAS No. 142 have been assessed. Management estimates that the annual amortization charges in respect of intangible fixed assets held at June 30, 2004 will be approximately $45 million for each of the five years to June 30, 2009. Estimated amortization expense can be affected by various factors including future acquisitions, disposals of product rights and the technological advancement and regulatory approval of competitor products.

The amortization charge for the six months to June 30, 2004 was $19.1 million (2003: $17.1 million).

During the six months ended June 30, 2004, the Company reviewed its existing product base. On completion of this exercise, management did not identify any impairments to be recorded on its existing product base.

9. Long-term debt

The main component of borrowings is $370.2 million (December 31, 2003: $370.2 million) in guaranteed convertible loan notes due 2011. However, at the choice of investors, each $1,000 of nominal value notes can be converted into 49.62 Shire ordinary shares (subject to adjustment) or 16.54 Shire ADSs (subject to adjustment) at any time up to August 21, 2011. Alternatively, investors can choose to receive repayment of the nominal principal in cash either at the maturity date of August 21, 2011 or by exercising a put option on any of the three put dates being August 21, 2004, August 21, 2006 and August 21, 2008.

The decision as to whether a note holder should exercise a put option will depend on a number of factors, particularly the price of Shire shares at the put date and the likelihood of the Company’s share price exceeding the conversion threshold price. The conversion threshold price is equivalent to $20.15 or £11.11 (at the closing exchange rate on June 30, 2004) for Shire ordinary shares and $60.46 for Shire ADSs. If the price of Shire ordinary shares at the first put date of August 21, 2004 remains at a level similar to that at June 30, 2004 of £4.82 ($26.72 for Shire ADSs), the Company’s expectation is that note holders will choose to exercise their put options and therefore the Company has reclassified this debt as a current liability. The Company currently has adequate resources from which it could satisfy repayment of the entire convertible debt principal of $370.2 million.

During the three months to June 30, 2004 the Company did not issue debt or make any debt repayments, other than in respect of capital leases.

During the six months ended June 30, 2003 the Company repurchased $29.8 million of the $400.0 million 2% guaranteed convertible notes due 2011.

10. Reorganization and closures

(a) Reorganization

As discussed in Note 1 the Group has conducted a thorough strategic review. As part of this review the Company has developed a plan to achieve closer interaction between the Company’s development, marketing and sales activities.

This plan requires a variety of actions by the Company, the most significant of which is the consolidation of the North American sites from fourteen sites to four, including the opening of a new US headquarters office in Wayne, Pennsylvania. The cost of the reorganization is currently estimated to be $55 million in 2004, and the reorganization is expected to be completed towards the end of 2005. There are still elements of the plan that need to be finalized and these may impact the total estimated costs of the reorganization. The main types of costs that will be incurred are as follows:

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• The severance of employees;
  
• Retention payments to key employees;
  
• The relocation of employees;
  
• Lease termination costs; and
  
• Other incremental costs associated with the site closures, such as legal, consultancy, the write down of property, plant and equipment and duplicate facilities.

The reorganization will result in:

The Company estimates that the first site will close towards the end of 2004.

The following table presents the cost of the reorganization recorded to date and the total estimated costs for the reorganization which will be incurred in 2004 and 2005. After the plan is finalized and actions are completed, the Company will continue to update its estimate of costs to be incurred. These costs will be recorded when the costs meet the definition of a liability.

The costs have been reflected within reorganization costs in the statement of operations and within the reporting segments as follows:

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As noted above, certain of the costs associated with the reorganization will be incurred in subsequent periods. The following provides a reconciliation of the liability that has been recorded as of June 30, 2004.

(b) Closure of Lead Optimization

On July 31, 2003, Shire announced its decision to close Lead Optimization as a result of a strategic review. The closure resulted in:

• The severance of 134 Lead Optimization employees. As of June 30, 2004, all employees had left the Company. Severance payments are being made to the former employees over a fifteen month period ending in the first half of 2005, as required by local regulations;
  
  
• A $6.0 million write-off of associated tangible fixed assets. These assets, primarily laboratory equipment, were used by Lead Optimization for research and development and have no alternative use; and
  
  
• The cancellation, to the extent possible, of contracts directly relating to Lead Optimization.

The costs have been reflected in the statement of operations in the year ended December 31, 2003 and within the reporting segments as follows:

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As noted above, certain of the costs associated with the closure will be incurred in subsequent periods. The following table provides a reconciliation of the liability that has been recorded as of June 30, 2004.

11. Consolidated statement of changes in shareholders’ equity